Never Use Miscellaneous as a Category in Your Financials

I am always skeptical about the value of financial statements that include the word miscellaneous.  I was reviewing the financials on a practice that one of my Virtual CEO clients is considering purchasing.  Imagine my alarm when I discovered that the not only did the P & L contain an expense category called “Miscellaneous” but the 2016 year to date total in miscellaneous was $120,000.  It is a large practice but $120,000 is a big number.

The practice is not as profitable as it should be and the seller assured us that there were no personal expenses being run through the practice. Year to date compensation seemed reasonable, less than 40% and the cost of goods sold was high at 28% When I asked about the $15,000 per month that was being spent on miscellaneous, the practice owner had no idea what it was and sheepishly admitted that he really only looks at the net profit on the P & L in the December financials.  We couldn't reach the book keeper because she is on vacation so the transaction is on hold until we can learn what is in “Miscellaneous”.

How will the story end?  Has someone been embezzling $15,000 per month or is there a perfectly reasonable explanation?  There are a dozen ways that either answer could be right, especially in a practice that the employees know the owner never looks at the financials. 

Is the category filled with unauthorized credit card charges someone is making on the practice card?  Is the book keeper, a family friend, a coconspirator or just incompetent?  Perhaps some leasehold improvement costs were dumped into miscellaneous because the book keeper couldn’t find a category that seemed right. 

If the cost of goods sold had been low, I might suspect that the credit card charges for drugs and supplies are being swept from the card company into the practice quick books account and no one has ever set up the categories.  But since the cost of goods sold is high, the automated credit card sweep into QuickBooks is probably not the answer. 

Maybe an associate is using a credit card to buy supplies and instruments so that when she leaves and opens her own practice she will be all set up on day one, sort of a pre severance package that she has given herself.

The buyer is having second thoughts and reasonably so.  The seller is embarrassed, a little defensive and probably worried.  This is the nightmare situation everyone dreads when they think about selling a practice.  The whole meltdown would have been avoided if the P & L did not have a category called “Miscellaneous”.

The take home lesson is, no good can come from using miscellaneous as a category in your financials!  IRS auditors throw the red flag when they see that category.  Buyers run for the hills when they see that category.  Bankers don’t want to loan money when they see that category.    

I suggest that you and your book keeper commit to having miscellaneous category eliminated by the end of next month.   

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